SAN FRANCISCO/LOS ANGELES, Aug 12 (Reuters) - California,whose green ambitions helped the solar and wind industries takeroot, is taking an essential next step by proposing a sharp risein energy storage to better integrate renewable power with therest of the grid.

Power from sun and wind fluctuates dramatically, socapturing it for later use makes the supply more predictable.

"We can't just rely on sunlight," Governor Jerry Brown toldthe Intersolar conference in San Francisco last month. "We'vegot to bottle the sunlight."

California's storage push comes as renewables move toward amandated one-third of the state's electricity supply by 2020.The proposal has fired up a technology race that has alreadyattracted venture capitalists Peter Thiel and Vinod Khosla,large-scale battery makers such as LG Chem, and establishmentforces like General Electric Co and Microsoft Corp founder Bill Gates.

It isn't just about California. Germany is a storagepioneer, and in the United States, stimulus funds have backedprojects in states such as New York and Texas.

But the Golden State's aggressive renewables target isforcing the issue here: it wants storage of up to 1.3 gigawattsby 2020. That capacity is enough for traditional plants to powermore than a million homes.

Lux Research analyst Steven Minnihan said California'sproposal is the first legislation that will have an immediateand lasting impact on the grid storage market, which heestimates will soar to installations worth $10.4 billion in 2017from just $200 million last year.

But storage is costly when compared to building new gasplants, and many storage projects were set up with the help ofstimulus funds that have since run dry, meaning utilitycustomers will end up with much of the tab. There are also risksthat unproven storage technologies will not deliver on theirpromise.

"The ratepayers would be on the hook," said Farzad Ghazzagh,who is analyzing the proposal for the Division of RatepayerAdvocates, an arm of the California Public Utilities Commission.His analysis is not complete, but Ghazzagh has seen estimates of$1 billion to $3 billion to install so much storage.

Proponents argue ratepayers will benefit because storageenables utilities to avoid building power plants or transmissionto meet peak demand, simply by providing extra power for a fewhours a day. The Electric Power Research Institute found in areport for California's grid regulator this summer thatstorage's cost is worth it if all benefits are considered.

As in solar manufacturing, the storage business has had itsshare of difficulties as it struggled to bring costs down andprove technologies. Battery maker A123 Systems and flywheelmaker Beacon Power LLC were among the most high profile, bothfiling for bankruptcy after receiving generous support from theU.S. Department of Energy (DoE).

Both have reinvented themselves under new ownership. A123was bought for $257 million by the U.S. unit of Chinese autoparts maker Wanxiang, and still makes grid-scale batteries,selling one to Hawaii's Maui Electric Company in June.

Beacon was snapped up by energy-focused private equity firmRockland Capital for $30.5 million and is working on a newproject in Pennsylvania with government backing. A third projectwill not need government support, according to Scott Harlan,Rockland's managing partner.

Beyond batteries, Gates, Thiel and Khosla all invested thisyear in compressed air startup LightSail Energy, which in Maywas awarded $1.7 million from the California Energy Commissionto demonstrate its technology at a Ventura County naval base.Gates and Khosla also invested together in another storagestartup - battery company Ambri.

"Grid scale storage has always been one of the areas that weknew and know will happen. It's a matter of timing," said AndrewChung, a partner with Khosla Ventures.

California's push "really cracks open the door" for startupsthat until now have had difficulty expanding small pilotprojects into big purchases, Chung added.

The true impact of California's initiative will be feltbetween 2020 and 2030, Lux's Minnihan said, and he expects themove to inspire efforts by other states.

"HOLY GRAIL"

Storage is seen as energy's "holy grail" because of theefficiency it brings to any grid. For example, California has 51gigawatts of peak capacity to handle heat that boostsair-conditioning demand, even if only two-thirds of that isneeded for most of the year.

Still, without more government money, utilities like PG&E, Southern California Edison and San Diego'sSempra Energy will shoulder much of the upfront costs.

A natural gas-fired plant costs about $1,000 per kilowatt tobuild, whereas EPRI's base case for a battery substitute has abreakeven capital cost of $1,684 per kilowatt.